As the Internal Revenue Service prepares for the annual deluge of income tax filings, it is also preparing for a problem that has become a more frequent occurrence in recent years — false tax refund applications filed by prisoners.

In 2005, IRS officials found $68 million in false tax refund applications filed in 2004 by 18,000 inmates. Of the $68 million, $14.7 million in refunds made it into prisoners’ hands, according to the U.S. Department of the Treasury. Some of that money was likely used to traffic drugs into prisons along with other contraband, such as cell phones, according to prison officials.

Abetted by red tape that prohibits the IRS and prison officials from freely working together, the number of false tax claims filed by inmates has increased exponentially during the last five years. In 2000, inmate refund fraud comprised 4.3 percent of total false returns. By 2004, the number of false inmate claims jumped to 15.4 percent, while the number of inmate filings represented less than 1 percent of total filings.

Similar to other illegal inmate activities, tax fraud schemes are changed constantly to avoid detection. Methods used by inmates to bilk the IRS are as varied as methods used by criminals that are not behind bars. The IRS has found prisoners that have simply filed false wages and earned income credit claims, and inmates that have profited from complex identity theft schemes. All of the successful inmates have help from a partner on the outside and they sometime work in groups on the inside, according to prison officials. The schemes have also led to staff corruption.

The problem has caught the attention of the U.S. House of Representatives Committee on Ways and Means, which addressed the issue during a June subcommittee hearing. During the hearing, legislators heard testimony from an anonymous convict who duped the IRS and received thousands of dollars illegally. The IRS’s lead investigator, the U.S. Department of Treasury inspector general for tax administration and prison officials also testified at the hearings.

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Until recently, the IRS had no comprehensive policy for addressing prisoner tax fraud.

“With prisoners filing increasing numbers of fraudulent returns, one would expect a strong, coordinated response from the IRS to combat these schemes,” said Russell George, treasury inspector general for tax administration, at the hearing. “Unfortunately, until recently, the IRS did not have an overall comprehensive approach to working with federal and state prison officials to address tax fraud.”

Before the IRS modified its policy, the agency neglected to create a central plan for addressing inmate tax fraud and instead left its 10 fraud detection centers to formulate individual plans. The Department of Treasury found that four of the detection centers failed to address the problem.

The tax agency now works more closely with prison officials, but IRS policy and a federal law designed to protect privacy rights prohibit IRS investigators from sharing specific details about false claims they are investigating.

The direct impact of the policy was amplified in testimony by officials from the Texas Department of Criminal Justice and the South Carolina Department of Corrections.

Jeff Bentley, South Carolina DOC criminal investigator testified that, “The IRS stated that Evans Correctional Institution had the second-largest number of fraudulent returns based on their prisoner database information. This information was not revealed to us until [late June 2005]. In late 2004, Evans Correctional Institution was placed on total lockdown due to rampant criminal behavior. The amount of contraband drugs, cash and other contraband, such as cell phones being confiscated, was phenomenally high, as were allegations of employee misconduct. For a period of approximately two months … staffing was at least doubled, and at times more, in an effort to bring the situation under control.”

John M. Moriarty, inspector general at TDCJ, told the subcommittee that the effort to quell inmate tax fraud is greatly hindered by the IRS’ inability to disclose the names of inmates it is investigating. At the time of the hearing, the Inspector General’s office had only one active case involving inmate tax fraud, while the IRS was investigating 250 possible cases that involved Texas inmates, according to Moriarty.

“It would be beneficial for my office, as well as all taxpayers, to determine whether the inmate suspects are committing these crimes when they are in the custody of the State of Texas, federal custody or in county jails” Moriarty said. “… A cooperative effort is necessary to be successful in combating the problem.”

However, when the IRS works with prison officials other problems arise. In an attempt to keep tabs on inmate tax refund applications, the IRS requests inmate information from state, federal and other correctional agencies.

“Their cooperation in providing prisoner identifying data, which we load into the data mining systems is absolutely vital to our detection efforts,” said Nancy Jardini, the chief IRS investigator, during the subcommittee hearing.

But that system also has serious problems that need to be resolved. Retrieving the data is often a low priority for corrections officials, according to the IRS, and data is often inaccurate and disparate among different agencies.

“Almost 20 percent of the data that we receive from the states is inaccurate,” Jardini said. “Further, the disparate formats utilized by the individual states are time-consuming and difficult to reconfigure to upload into our systems.”

Prosecution Problems

To complicate the matter even more, prosecution of inmates who commit tax fraud is a low priority for government prosecutors.

In Florida — the state with the highest amount of detected inmate tax fraud — and other states, with the exception of specific instances tax forms are considered contraband. Checks from the IRS that enter established inmate bank accounts are flagged and the tax agency is notified. When evidence of tax fraud is found it is also forwarded to the IRS. At that point, the prison agency is eliminated from the investigation process.

“What happens with the cases 99 percent of the time? We don’t know,” says Walt Murphree, deputy inspector general at the Florida Department of Corrections.

According to the IRS, most of the information submitted by prison officials doesn’t materialize into prosecutions, not because of lack of evidence, but because it is usually near the bottom of the lengthy “to do” list of U.S. Justice Department prosecutors that handle criminal tax fraud cases.

Of the 122,000 overall tax fraud cases detected in 2004 — including the 18,000 cases of inmate tax fraud — only 500 were prosecuted.

“When you consider — and this is not by any means a criticism of the Department of Justice — that their limited resources are deployed to counterterrorism, corporate fraud, narcotics, general crimes and violent crimes, investigating a prisoner who is already sitting in a South Carolina prison for 25 years and using prosecutorial resources for that type of investigation is not at the top of their list of priorities,” Jardini said at the hearing.

Several federal officials and prison officials believe limiting privileges and administrative punishment are a more effective deterrent for inmates serving long prison sentences that are found guilty of tax fraud.

“If prisons could take away prisoners’ administrative privileges for engaging in this conduct — the oh-so-important cigarettes, candy bars, television and visitation privileges — it would create a cost-effective deterrent that would benefit both the federal government and prison system,” Jardini said.

Help Is on the Way?

Limitations notwithstanding, the IRS works extensively with several prison agencies in an attempt to eliminate inmate tax fraud.

Last year, the IRS met with Florida prison officials during a daylong seminar designed to determine the best approach to dealing with the problem.

“We have a very good relationship with the IRS criminal investigation department,” Murphree said.

The IRS also attended five meetings held regionally at five different locations throughout the state.

“It was a very rewarding experience I think for everyone,” Murphree said.

Many of the disclosure problems that limit collaboration between the IRS and prison officials could be eliminated if a bill introduced to the U.S. House of Representatives Dec. 13 is approved.

If passed, the Prison Inmate Tax Fraud Reduction Act would amend IRS policy to allow the agency to disclose certain return information of prisoners to prison officials. If there were sufficient evidence that an inmate may be committing tax fraud, prison officials could request information from the IRS.

Inmates found guilty of committing tax fraud could then be prosecuted administratively without waiting for the Justice Department to prosecute. The bill is in the committee process now and the House and Senate must pass it before it is submitted to President Bush for approval.